Topics in Trade: Slides

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1 Topics in Trade: Slides Alexander Tarasov University of Munich Summer 2012 Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

2 Organization Classes: Tuesday (Ludwigstr. 28, VG, 021) Friday (Ludwigstrasse 28, Vgb., Room 221) Ofce hours: Tuesday, and by appointment Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

3 Requirements Master students: Class presentation (30%): 30-minute talk in class at the end of the semester. Final exam (70%): one hour, last class (July 20th). Ph.D. students: Class presentation (20%): 45-minute talk in class at the end of the semester. Three homeworks (20%). Final exam (60%): two hours, last class (July 20th). Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

4 Course Outline: Several Trade Facts More than 50% of total trade ows happen between developed countries; about 15% between developing counties; about 30% between developed and developing countries. Rising importance of China: Chinese exports increased 30-fold from 1978 to 2008 (from 2 to 40% of GDP). More than 40% of U.S. trade ows happen between rms boundaries....and so on. Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

5 Course Outline: Trade Theory Trade theory tries to answer the following questions: What explains the pattern of trade across countries? What goods do countries trade? Which kind of rms trade? What is the role of FDI and multinational production? How do they affect trade patterns? What can explain the growth in trade? Does trade affect GDP growth? What are the effects of trade on the labor markets? Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

6 Course Outline: Trade Theory 1817: Ricardo's Principles of Political Economy and Taxation THEORY OF COMPARATIVE ADVANTAGE: a country exports products in which its labor productivity is high relative to its labor productivity in other products. 1920s: Heckscher-Ohlin FACTOR ENDOWMENTS DETERMINE THE PATTERN OF TRADE: a country should export the product that is relatively intensive in using the factor with which the country is relatively well-endowed. Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

7 Course Outline: Trade Theory Krugman (1979): new, complementary theory based on ECONOMIES OF SCALE and PRODUCT DIFFERENTIATION. Motivated by: Large volumes of trade between countries with similar factor proportions. Large volumes of intra-industry trade. None of this seems motivated by factor endowment and technology differences Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

8 Course Outline: Road map Basic Trade Theories (Old Trade Theory): Heckscher-Ohlin and Ricardian models trade between different countries New Trade Theory: Krugman model trade between similar countries "New New" Trade Theory: Melitz and EK models Assorted Topics: Firm Boundaries and Trade, Multinational Production, Income Distribution and Trade Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

9 The Heckscher-Ohlin Model: The Model How do factor endowments form trade patterns? Framework: two factors of production (two inputs): labor and capital two sectors: y i = f i (L i, K i ) where i = 1, 2 is the sector index, L i is labor, K i is capital. f i (, ) is increasing in both arguments, concave (diminishing marginal returns), homogenous of degree one: f i (λl i, λk i ) = λf i (L i, K i ) Labor and capital are full mobile between sectors, but not between countries. Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

10 The Heckscher-Ohlin Model: The Model Resource constraint: Production Possibility Frontier: subject to L 1 + L 2 L K 1 + K 2 K max y 2 = f 2 (L 2, K 2 ) fl 2,K 2 g L 1 + L 2 = L K 1 + K 2 = K y 1 = f 1 (L 1, K 1 ). Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

11 The Heckscher-Ohlin Model: The Model From the maximization problem: y 2 = h(y 1, L, K ), this is the PPF (PICTURE). The economy can produce any amount of goods within the PPF. Additional assumptions: perfect competition in the product and factor markets product prices are given exogenously (a small open economy), there are some world prices this assumption will be omitted later Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

12 The Heckscher-Ohlin Model: The Model Industry outputs are such that max fy 1,y 2 g GDP = p 1y 1 + p 2 y 2 subject to y 2 = h(y 1, L, K ). Why do in competitive equilibrium industry outputs maximize GDP (homework)? PICTURE Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

13 The Heckscher-Ohlin Model: Equilibrium Switch to unit-cost function: c i (w, r) = min L i,k i fwl i + rk i j f i (K i, L i ) = 1g where w and r are prices of labor and capital, respectively. c i (w, r) is the cost of one unit of y i (given the optimal choice of labor and capital) We can write c i (w, r) = wa il + ra ik, where a il and a ik is the rm optimal choices (endogenous variables): a il = a il (w, r), a ik = a ik (w, r). Envelope theorem: c i w = a il and c i r = a ik. Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

14 The Heckscher-Ohlin Model: Equilibrium Both goods are produced! Perfect competition implies that prots are equal to zero: p 1 = c 1 (w, r) p 2 = c 2 (w, r) Full employment of both resources: a 1L y 1 + a 2L y 2 = L a 1K y 1 + a 2K y 2 = K Four equations and four unknowns ((w, r) and (y 1, y 2 )). Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

15 The Heckscher-Ohlin Model: Factor Intensity Reversals Suppose a 1L a 1K > a 2L a 2K, then industry 1 is labor intensive for given (w, r). If the inequality holds for all possible (w, r), there is no Factor Intensity Reversals!! for any values factor prices, industry 1 is labor intensive. Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

16 The Heckscher-Ohlin Model: Analysis of Equilibrium Proposition: If both goods are produced and Factor Intensity Reversals do not occur then (p 1, p 2 ) corresponds to a unique (w, r) Corollary: Factor prices do not depend on the amount of endowments PICTURE (two equilibria)! Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

17 The Heckscher-Ohlin Model: Analysis of Equilibrium Does the no Factor Intensity Reversals condition always hold? Example (the textbook): Footwear industry in the United States A "New Balance" plant produces in the US, pays 14$ per hour, and uses high-tech equipment (automated stitchers, etc.): capital-intensive production Nike, Reebook, and other employ Asia labor force, pay 1$ per hour, and use century-old equipment: labor-intensive production Hence, if wage is low, production is labor-intensive. If wage is high, then production is capital-intensive We observe Factor Intensity Reversals! Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

18 The Heckscher-Ohlin Model: Factor Price Equalization Assume for the moment that there are two countries technologies are identical different factor endowments If both countries produce both goods and FIRs do not occur, then (w, r) are equalized across the countries. Comments: the number of goods is equal to the number of factors: important! technology is the same, both good should be produced! Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19

19 The Heckscher-Ohlin Model: Stolper-Samuelson Theorem (1941) How product prices affect Factor prices? Theorem A rise in the relative price of a good will increase the real return to the factor used intensively in that good, and reduce return to the other factor. Proof. In the class! NOTE: There are strong distributional consequences, making some people worse off and some better off! See also the picture in the class. Alexander Tarasov (University of Munich) Topics in Trade (Lecture 1) Summer / 19